Friday, January 27, 2006

Dominique de Villepin, France's prime minister, wants to loosen job protection rights for young workers. A recent Financial Times article (de Villepin labour reforms) highlights de Villepin's labor proposal. Existing French labor laws make it difficult and expensive for French firms to fire workers. The laws intend to prevent companies from dismissing employees on a whim. But job protection rights have some unintended consequences as well.

To analyze the effects of the laws, imagine yourself as a French business owner. Suppose a young, inexperienced worker applies for a position with your firm. There's a 50 percent chance she will work hard and a 50 percent chance she will slack off. You might be less willing to take a chance on this inexperienced worker if you face high dismissal costs in the event that she's a slacker. In short, French laws designed to protect workers actually create a disincentive for businesses to hire young, inexperienced workers in the first place. Some argue that this accounts for the sky-high youth unemployment rate in France, which currently stands at 23%--and even higher among immigrant populations.

De Villepin's reform would allow companies to hire workers ages 26 and under on a two-year trial basis. If a young worker excels during the two-year trial, she gets a full-time contract and all of the job protection rights that come with it. But if she doesn't, the employer could let her go at no cost. De Villepin argues that these looser firing restrictions would encourage firms to hire more young workers, driving down the youth unemployment rate.

De Villepin is not the first to propose such reforms. Each time officials proposed youth labor reforms in the past, massive labor union and student protests derailed the legislation--de Villepin can expect more of the same.

1. In addition to job protection measures, France offers comparatively generous unemployment insurance payments and high minimum wages. How do these policies affect the demand for inexperienced youth labor?

2. Would you classify the unemployment created by government legislation such as the minimum wage or firing restrictions as structural, frictional, or cyclical?

Wednesday, January 25, 2006

In a recent article in the New York Times, it is reported that Chinese billionaires are advertising for brides--specifically, virgin brides. This has been met with reactions ranging from enthusiasm to disgust. One respondent to the ads posted to an online discussion board saying, "Isn't the purpose of saving our virginity to get a good price?" Other readers promptly compared people like her to prostitutes. "I'm also a well-educated woman with a good figure, too, but I hate this kind of thing," wrote one reader. "People's beauty derives from their inner qualities, not their virginity. Those girls have sold themselves like cheap merchandise."

The model of supply and demand works great for a commodity like corn. But what about marriage? Should there be a market for brides--or grooms? Do the efficiency predictions of classical economics apply in the realm of Eros?

To answer this question, it's important to be clear about how the assumptions of the classical economic model drive its results about efficiency. In a model of supply and demand, there is a particular "good" in question, like corn. But in a "marriage market," there is no good--rather, the "product" of such a market is measured in matches, or pairings of two individuals.

The efficiency of such a market is not measured in the quantity of matches--if everyone wanted to get married, and there were roughly equivalent numbers of men and women, then everyone could. Rather, whether the pairing of people in a marriage market is efficient depends on the quality of the matches. Are spouses compatible with one another? Are the most number of people happy? Are the marriages stable?

This brings us back to the question of billionaires advertising:

1. Do these advertisements help in achieving efficiency in the marriage market? Why or why not?

2. Do you agree with the reader of the Chinese newspaper who felt that the respondents to these ads are "no different than prostitutes"? Why or why not?

3. Do people always get what they bargained for in the marriage market? Besides advertising, what methods do people use to find suitable spouses? What economic problems do these methods help to overcome?

4. Try the following exercise: Consider the cast of "Friends." Make up rankings for each of the characters, stating which of the other Friends they would like to marry. (For example, suppose Chandler would most like to marry Monica, then Rachel, then Phoebe.) Of all the possible sets of matches, can you say that one is more "efficient" than another? (Hint: you might consider a set of pairings inefficient if there is a pair of couples where each would be made better off if they swapped husbands.)

Hugo Chavez, Venezuela's president, set lofty goals for regulating the coffee market--keep prices low for consumers and ensure farmers get a high price for their coffee beans. On the surface, Chavez appears to be making all the right political moves: helping poor coffee farmers and reaching voters where it counts--through their coffee mugs.

But, as you've learned in your econ class, government attempts to control prices usually end in turmoil. The coffee market hasn't behaved according to Chavez's plans. His solution: send in the National Guard. Apparently, an under-caffeinated population is a matter of national security. Read on to find out more about Venezuela's coffee chaos.

1. How are coffee producers--the companies that roast and process coffee beans--getting squeezed by President Chavez's price controls? How did the coffee producers respond to the price controls?

2. Chavez sets both the prices coffee producers pay to farmers and the prices coffee producers receive from consumers. Is the regulated price that producers pay to farmers an example of a price floor or a price ceiling? What about the price producers receive from consumers?

3. Chavez implements price controls on a variety of foodstuffs in Venezuela, including powdered milk and maize. What consequences do the price controls have in Venezuelan supermarkets?

4. How do you think coffee producers will respond to the government's coffee expropriation?

5. Chavez threatened to nationalize the coffee industry. Coffee producers often incur a loss after selling their coffee under current price controls. Assuming the government would incur the same costs as private coffee producers, who would make up for the government's loss on coffee production?

Friday, January 20, 2006

Sky-high oil prices and concerns over global warming have sparked a debate about renewable energy sources. One such alternative is to use biological fuels (rather than fossil fuels like oil) to power automobile cars. Willie Nelson has started selling BioWillie, a form of diesel made in part from vegetable oil. And ethanol, a form of gasoline made from corn, has begun to take off as a viable alternative to traditional gasoline in cars.

The possibility of using corn to produce fuel is one that is obviously attractive to the nation's corn growers. But if the United States were to start using corn as a significant source of energy, would that mean that the rest of the world would have less to eat? Would poor children go starving just so yuppies could drive their SUVs? This article in the New York Times examines that possibility, but some simple economic analysis shows that these fears are unfounded.

Consider the market for corn in Iowa. Usually, demand in the market comes from animal feed producers and food processors, who make the corn into corn syrup for use in things like Danish pastries. However, this year, demand for corn increased because there are more buyers in the corn market: namely, ethanol producers.

In the short run--that is, after the corn has been harvested in a given year--the supply of corn is fixed. This is sometimes called a momentary supply curve. (You can see the fixed supply of corn in the picture in the article--it's that giant 35-foot pile in the main photo!) Therefore higher demand translates into higher prices, as is shown in Figure 1.

In the long run, though, higher prices for corn will mean that more corn will be produced. (In fact, as the article mentions, the U.S. government actually pays corn farmers NOT to farm 35 million acres of corn.) Because of these agricultural subsidies, in fact, third-world farmers are priced out of the market--so they don't plant corn. Higher demand for corn, in the long run, would mean that both U.S. producers and world producers would have more incentive to plant corn. Therefore, the long-run supply curve of corn is much more elastic (i.e., much flatter) than the momentary supply curve--so the same shift in the demand causes a smaller increase in prices, and enough corn to be planted to satisfy the need for food and fuel, as shown in Figure 2. In the long run, an increase in the demand for corn increases the amount of corn produced and consumed in the world.

1. The article quotes Lester R. Brown, an agriculture expert in Washington, D.C., and president of the Earth Policy Institute, as saying, "We're putting the supermarket in competition with the corner filling station for the output of the farm." Draw a PPF showing how much food and fuel an economy can produce with a given amount of corn. What aspect of your drawing represents the tradeoff that Mr. Brown describes? Now draw another PPF showing how much food and fuel an economy can produce if twice as much corn is planted. In what sense are short-run tradeoffs different from those in the long run?

2. Draw a supply and demand graph of the market for corn. What would happen in this diagram if the United States stopped paying corn farmers NOT to farm that 35 million acres of corn?

3. Much of the corn grown in the United States is used for animal feed. What effect would an increase in the price of Iowa corn have on the market for hamburgers?

4. What other short-run tradeoffs might be rendered irrelevant by long-term market adjustments

Thursday, January 19, 2006

The U.S. House of Representatives passed a bill last month that included provisions to build a 700-mile wall along the U.S.-Mexico border. The following news articles describe both the political and economic dimensions in this debate.

The falling wages of low-skilled workers in the United States is often attributed to an increase in the number of low-skilled immigrants to the United States. However, there are alternative explanations for the fall in low-skilled wages that have nothing to do with immigration.A simple supply-and-demand model can provide us with valuable insight on the labor market and its relationship to immigration and capital. Consider the labor market for low-skilled workers. An increase in low-skilled immigrants would increase the supply of low-skilled labor and lower the wage of low-skilled workers in the United States. (Graph I)

However, suppose immigration has no effect on low-skilled wages. Is it still possible to observe a decline in low-skilled wages? Yes. The demand side of the labor market has as much, if not more, impact on wages than the supply side. Capital and technology can be substitutes for low-skilled labor. As the U.S. economy accumulates more labor-saving capital and technologies, the marginal product of low-skilled labor decreases. This causes the demand for low-skilled labor to fall and wages for low-skilled labor to fall as well. (Graph II)

At the same time, capital accumulation and technological innovation raise the marginal product of labor for high-skilled labor to operate and maintain the new machines and ideas. Hence, we expect wages for high-skilled workers to rise in the United States.

Discussion Questions

1. What effect would building a wall along the U.S.-Mexico border have on wages in the United States?

2. If low-skilled workers are displaced by capital (rather than immigration), then what policies should the government pursue?

3. Economists often use cost-benefit analysis to determine whether a policy is worth implementing. What are the costs of immigration imposed on taxpayers, households, and firms? What are the benefits?

4. Economists generally agree that the free trade of goods and services benefits both trading countries. If the free trade of output makes the world better off, does the free trade of inputs (labor) also make the world better off?

For more information on the economic analysis of immigration, you might want to check out the work of George Borjas, from Harvard University, and David Card, from University of California at Berkeley.

How's this for the essay question on your next econ exam: What's the total cost of toppling Saddam Hussein and battling insurgents in Iraq? Round your answer to the nearest billion dollars and explain your tabulation.

Two recent economic research papers set out to answer this question. One study, authored by scholars from the American Enterprise Institute, estimates the cost at a minimum of $657 billion. Another study, authored by Joseph Stiglitz of Columbia and Linda Bilmes of Harvard, puts the total cost of war at upwards of $2 trillion. These estimates dwarf the initial White House projections of $200 billion, and even the $357 billion appropriated by Congress in 2002 for fighting in Afghanistan and Iraq. Why are the estimates so different?

To interpret the estimates we need to understand that the cost of war exceeds the government expenditures on fighting it. Fighting a war presents a host of opportunity costs and disruptions that do not show up in the government budget reports. Initial White House projections attempted to account for explicit costs associated with military operations in Iraq. The economic studies attempt to account for both the explicit costs and the opportunity costs that the war will generate for years to come.

War cost accounting is an inexact but informative science. Read on to see what types of questions economists try to answer when estimating the costs of war.

1. What is the Congressional Budget Office's estimate for explicit costs associated with military operations in Iraq over the next decade?

2. What are the opportunity costs of sending National Guardsmen or reservists to Iraq for extended tours of duty? What types of health care costs will the United States incur after the war? What are the opportunity costs associated with an injured soldier who cannot return to normal work after the war?

3. According to the researchers, what effect did the war in Iraq have on oil prices?

4. The high costs of the Iraq war do not necessarily mean it was a bad idea. What are the benefits associated with the war in Iraq? Are the costs of withdrawing troops from Iraq greater than the costs of keeping the troops there?

A nation's GDP is determined by its labor force, its capital stock, and its technological knowledge. An increase in the amount of capital per worker increases a nation's GDP. An improvement in technology allows a nation to get more GDP out of its existing capital stock. Technology refers to the way an economy organizes its labor and capital to produce goods and services. If two nations have the same number of workers and capital but one nation uses better technology to get more out of its labor and capital, it will generate more GDP. The nation with better technology has higher productivity--it gets more output per hour of labor input.

A recent Hal Varian commentary in the New York Times focused on the role of technological knowledge in explaining the different productivity experiences of Europe and the United States. Compared to Europe, the United States experienced much stronger growth in output per labor hour over the past decade. Why? The evidence suggests that American firms integrate information technology more quickly than their European counterparts. Follow the link to find out more:

1. What happened to the rate of productivity growth in the United States over the past three decades? What industries have been fueling productivity growth in the United States?

2. A computer, like an electric motor, is simply capital--a physical resource. Technology refers to the way that we organize our resources to produce goods and services. An improvement in technology occurs when we have a bright idea that allows us to produce more of the things we want from the same (or fewer) resources.

What technological improvement created a productivity boom by putting the electric motor to a novel use?

3. Given that American and European firms have access to the same information technology capital, why are American firms more productive?

4. What are the differences between British firms and American firms located in Britain when it comes to information technology capital per worker?

5. Consider two made-up firms: Initech and Initrode. Initech emphasizes experience- based promotions, a system that benefits older workers who have worked there for a long time. Initrode emphasizes merit-based pay, a system that allows the brightest young workers to move up quickly. In which firm would you expect managerial comfort with information technology to be highest?

Thursday, January 12, 2006

I was on a plane flight coming back from the annual meeting of the AEA (the American Economic Association) and the on-flight entertainment included a famous clip from comedian Chris Rock:

And everybody's talking about gun control, got to get rid of the guns...You don't need no gun control. You know what you need?

We need some bullet control.

Man, we need to control the bullets, that's right. I think all bullets should cost $5,000. $5,000 for a bullet. You know why? 'Cause if a bullet costs $5,000 there'd be no more innocent bystanders.

That'd be it. Every time someone gets shot, people will be like, “Damn, he must have did something...”

People would think before they killed somebody, if a bullet cost $5,000. “Man, I would blow your $!#@#$ head off, if I could afford it. I'm gonna get me another job, I'm gonna start saving some money... and you're a dead man. You better hope I can't get no bullets on layaway.”

The point of the routine--and it's one that comes up over and over again in economics--is that public policy objectives (like reducing the number of people killed by guns each year) can be achieved by manipulating the incentives people face. Furthermore, this method might be more effective than other policy instruments--for example, imposing a 48-hour waiting period on purchasing a handgun.

Can you try to use an economic model to formalize his argument? Here are some hints to get you going.

For simplicity, let's initially suppose that there is a market for killing people, in which the buyers are people with grievances and the sellers are professional assassins. These assassins need guns and bullets to do their work.

1. Consider the cost function for a single assassin (a firm). Is the cost of a gun a fixed or marginal cost? How would a 48-hour waiting period to buy a handgun affect the supply curve in the market for killings?

2. Again consider the cost function for a firm. Is the cost of bullets a fixed or marginal cost? How would a $5,000 per bullet tax affect the supply curve in the market for killings?While this is an outlandish example, it does shed some light on the incentives that people face, and how those incentives can be used to affect behavior. What other policy goals might be reached by changing incentives?

Wednesday, January 11, 2006

If you recently tried to purchase an Xbox 360 at the retail price of $300, then you were probably out of luck. Every retailer in the United States is completely sold out of the console, and retailers have no idea when they will have the console back in stock.

Shortages should cause prices to rise, but the market price of a Xbox 360 debuted at $300 and has stayed there (despite shortages). Microsoft is responding to the shortage by producing more Xbox 360's rather than raising prices.

A Keynesian economist is not surprised by Microsoft's short-run behavior. Let's examine the effects of sticky prices on the macroeconomy if every firm behaved like Microsoft. The graph on your right shows the Keynesian model, or the short-run macro model. Suppose the economy is producing $6 trillion worth of output, a level below the equilibrium output. Notice that when output equals $6 trillion, planned aggregate expenditure equals $8 trillion. In other words, planned spending exceeds output. According to the Keynesian model, prices are sticky, hence firms respond to excess demand by raising output, not raising prices.

Tuesday, January 10, 2006

Among the sources of economic growth, improvements in technology have the most dramatic effects. Advances in technology provide new and better ideas about using our resources. In short, improvements in technology allow us to get more of the things we like (goods, services, leisure time) given fixed, or even fewer, resources.

Economists (including the founder of Aplia, Paul Romer) and policy makers devote a lot of thought to developing technology policies. Economists generally agree on a couple of broad policy goals:

1. Government should promote education. A better educated population tends to come up with more bright ideas and universities tend to extend and deepen the basic knowledge that leads to better ideas in the first place.

2. Government should protect intellectual property, providing innovators with patents that reward them for developing better ideas -- an incentive to innovate.

This article from the Economist (Bayh-Dole Act), considers some of the difficulties of implementing successful technology policies. Patents provide an incentive for innovation, but as the article points out, the scramble to obtain patents and their consequent rewards may actually slow the spread of new ideas and basic knowledge. That is, excessively strict intellectual property laws (Goal 2) might actually hamper the spread of basic knowledge (Goal 1). Read the article to see why.

1. How does the Bayh-Dole Act foster innovation? According to the article, how many firms have the Act's patent protections helped to create? List some of the innovations resulting from the Act.

2. Like many government policies, the Bayh-Dole Act generates unintended consequences. In what ways does the Act deter or delay scientific research?

3. The Act attempts to exempt "non-commercial" research from patent restrictions. In what ways does the Bayh-Dole Act blur the line between the commercial and non-commercial scientific research conducted at universities?

4. Would non-exclusive licensing of patented ideas (rather than exclusive licensing) lead to more rapid dissemination of ideas and knowledge?

Sunday, January 08, 2006

In this Slate commentary, Tim Hartford explores the Starbucks strategy for price discrimination. Price discrimination occurs when a firm charges different prices for the same product. Because the product is the same, the price difference does not reflect difference in cost, rather it reflects differences in consumer willingness-to-pay.

Acoording to Hartford, Starbucks effectively charges high prices to customers with a higher willingness-to-pay by serving them cappucinos in larger cups. To understand Hartford's argument you need to assume that an 8-ounce (short) cappucino is essentially the same thing as a 12-ounce (tall) since both drinks contain the same amount of espresso. Starbucks baristas will gladly make you a smaller and, according to Hartford, higher-quality cappucino at a lower price. So, if short and tall cappucinos contain the same amount of espresso, and the short is arguably better than the tall, how does Starbucks manage to charge more for the tall cappucino? Follow the link to find out:

In the end, this pricing strategy works well for Starbucks. The firm keeps price sensitive cappucino connoisseurs coming back by offering (covertly) the less expensive, higher-quality 8-ounce drink. At the same time, Starbucks rakes in the maximum mark-up from unenlightened customers who willingly pay a bit more to quaff the super-sized cappucinos.

Price discrimination requires three conditions: market power, differences in consumer willingness-to-pay, and the ability of the firm to segment the market into consumers with high willingness-to-pay and consumers with low willingness-to-pay.

1. What type of firm is Starbucks: perfectly competitive, monopolistically competitive, oiligopoly, or monopoly? What is the source of Starbucks's market power?

2. Hartford claims that Starbucks's marginal production costs are the same, regardless of beverage size. List some of those costs.

3. What strategy does Starbucks use to split the market into consumers with high willingness-to-pay and lower willingness-to-pay?

4. What would happen to the company's profit margin and consumer base if Starbucks refused to make short cappucinos altogether?

5. Think about the other examples of price discrimination that Hartford cites. How does Tesco, the British grocer, price discriminate? Do you see similar tactics in American supermarkets?

6. What strategy did railroads use to segment their market? Were railroads really charging different prices for the same product, or does the roofless car represent a different product altogether?

Friday, January 06, 2006

You might expect real estate agents to make out like bandits during a housing bubble. After all, as University of Chicago economist Austan Goolsbee points out in his Slate commentary, agents receive a fixed portion of the value on any house they help to buy or sell. As house prices boom, so to do the payouts to real estate agents. Well, as research by two Berkeley economists suggests, real estate agents haven't exactly made out like bandits in the housing bubble--but they have multiplied like bunnies. Read on to see why:

Firms in competitive industries tend to earn zero economic profit over the long haul. That is, the owners earn just enough to keep them from shutting down and leaving the industry for their next best opportunity. The zero-profit condition holds in industries with low barriers to entry. Profitable firms in low entry barrier markets attract other firms hoping to grab a slice of the pie. With time, competition prevails and the zero profit condition holds. As Goolsbee points out, the market for real estate services shows the zero profit condition in action.

1. According to the article, what are the barriers to entry in the market for real estate services?

2. The housing boom generated higher realtor earnings per sale--but what's happening to the number of sales per realtor?

3. According to the study by Berkeley economists Enrico Moretti and Chiang-Tai Hsieh, what is the relationship between house prices and the productivity of real estate agents?